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Hedging With Futures to Combat Energy Volatility

March 6, 2018 by Daniels Trading| Ag Marketing

Energy costs are an unavoidable reality facing a broad spectrum of industries. For example, if you’re involved in transportation, agriculture, or even retail, it’s likely that you have a line item on the monthly budget exclusively for energy.

Guide to Smarter Ag Marketing

Energy plays a key role in almost every industrial sector. In many ways, it is the lifeblood of a developed nation’s economy. As a result, the relative performance of a wide range of industries — particularly utility providers, petroleum and refining services, and shipping/freight — is highly sensitive to fluctuations in the energy markets:

In order to insulate operations from the impact of energy pricing volatility, many business owners look to hedging with futures for a solution. Whether seeking insurance against a harsh winter or high fuel prices, standardized futures contracts can help mitigate a variety of foreseen and unforeseen risks.

Energy: Available Futures Products

The Chicago Mercantile Exchange (CME) offers participants in energy-sensitive industries numerous options for hedging risk. Contracts facing a variety of refined and unrefined products are readily available for active trade.

Product Symbol Description
WTI Crude Oil CL Light, sweet crude oil
Henry Hub Natural Gas NG Natural gas
RBOB Gasoline RB Gasoline fuel
NY Harbor ULSD HO Heating oil/ultra-low sulfur diesel
PJM Western Hub Peak-Month AL1 Electricity

In addition to the popular energy commodities contracts, there are several other “exotics” that are also used to diversify against risk. Contracts facing coal, propane, ethanol, and biodiesel are traded with less liquidity but remain viable hedging instruments.

Hedging Strategies: The Consumer/Producer Paradigm

Depending upon the industry, sensitivity to energy pricing varies wildly. Transportation, shipping, and similar sectors rely greatly on the pricing stability of refined fuels. On the other hand, companies in the oil and gas services industry benefit from higher prices in energy commodities.

In effect, this relationship illustrates the consumer/producer paradigm. While one group benefits from high energy prices, the other does not. However, no matter whether a party views high or low energy pricing as advantageous, hedging with futures can be a viable avenue of managing risk.

Business Energy Position Exposure (Risk) Hedge (Symbol)
Corn Farmer Consumer Rising fuel prices Long RB, HO
Airline Consumer Rising fuel prices Long HO
Motel/Hotel Consumer Rising energy costs Long AL1
Petroleum Services Producer Falling energy pricing Short CL, NG
Utilities Producer Falling energy pricing Short NG, HO

The goal of a consumer hedge is to protect against instability in the refined fuels or electricity market. A futures contract can be very helpful, in that a large scale consumer, such as an airline or a corn farmer, can “lock in” fuel pricing for an upcoming period. For instance, a corn farmer may buy the New York Harbor Low-Sulfur Diesel (HO) contract at the current market price in an attempt to insulate against a coming hike in diesel. If storage options are available, the farmer may elect to take delivery at contract expiry for use; if not, the contract is sold at market with gains offsetting the rise in fuel costs.

Conversely, energy producers are faced with the opposite problem. In the case of plummeting oil prices, a driller or oil field services provider may choose to take a short position in a related WTI Crude Oil (CL) contract. Gains from the open position may be used to reduce the impact of falling oil prices on operations. Large-scale producers may even elect to make delivery on the contract instead of liquidation to maximize the net benefit at contract expiry.

Active Hedging

Understanding the impact that energy has upon your business can be a complicated task. Fuel and commodity pricing are sometimes merely the tip of the iceberg. Consultation with an experienced energy expert is a great place to begin quantifying what energy means to your bottom line.

For a free consultation on how the futures markets may bring value to your operation, contact the team at Daniels Ag Marketing.

Guide to Smarter Ag Marketing

Filed Under: Ag Marketing

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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